Friday, December 4, 2015

Fed Headed for Higher Rates, ECB Stays Easy, Terrorism Hits US

Policy divergence between Europe and the United States was thrown into high
relief this week. On Thursday, the ECB extended its QE bond buying program to
March 2017 and cut its deposit rate further into negative territory, as
President Draghi said that Europe needed more support for longer. Then on
Friday, the November US jobs report beat expectations with strength seen across
all categories, all but requiring the Fed to hike rates at its policy meeting
in two weeks. The other major financial event was the OPEC summit, where the
cartel acknowledged the reality that its prior 30M bpd production ceiling was
clearly being ignored by member states. OPEC refrained from actually setting a
new production ceiling, though the organization's President eventually
confirmed the current production level is around 31.5M bpd. Markets were forced
to digest these key events against the backdrop of a horrific terrorist attack
in San Bernardino CA. In a volatile trading week, the S&P500 ended up 0.1%
and the DJIA and Nasdaq each gained 0.3%.

The November US jobs report was strong, with the non-farm total of +211K
beating expectations and the unemployment rate steady at a seven-year lows of
5.0%. Average hourly earnings saw additional modest gains after a big jump in
October. The report was the last big data point ahead of the Fed's two-day
policy meeting in two weeks. Ahead of the jobs number, Fed Chair Yellen had
said the labor market's progress was healthy enough to boost confidence that
the Fed may reach its 2% inflation target soon. Economists at BNP Paribas said
that after Friday's report it's "all systems go" for the Fed to raise
rates in December.

As expected, the ECB cut its deposit rate another tenth into negative
territory, to -0.30% and expanded its QE program. The central bank extended its
bond buying program by six months to March 2017 and said it would begin buying
regional government bonds, expanding the range of assets it can buy. Markets were
apparently disappointed that the ECB failed to boost the monthly purchase
amount of €60B, but Draghi defended the measures taken as "adequate."
In addition, the ECB said it would also commence reinvesting principal as bonds
mature, a move that Draghi later explained would add €680 in liquidity to the
system by 2019 in a speech on Friday

The ECB announcements resulted in volatile price action across a variety of
asset classes as markets appeared underwhelmed after weeks of buildup into the
additional stimulus measures. EUR/USD was testing seven-month lows around
1.0540 in the lead-up to the decision but quickly took out 1.0900 as Draghi
rolled out the new measures during the press conference. By mid-day on
Thursday, EUR/USD topped out around 1.0980, a one-month high, before trading
back below 1.0900 through week's end. Interest rates popped globally with
several markets experiencing the sharpest back up in yields in many years. The
German 2-year yield rose some 15 basis points after the ECB announcement while
UST yields climbed as well. Equities were hit hard in Europe and pressured in
the US as well until the solid November employment report sent US Indices
surging on Friday.

Australia's central bank kept rates unchanged for the seventh straight meeting
and largely reiterated the sentiment from last month's policy statement. The
RBA still sees prospects for an improvement in economic conditions having
firmed, inflation consistent with the target over the next 1-2 years, and AUD
currency adjusting to commodity decline. The biggest change in the language was
the admission of a large decline in capital spending in the mining industry.

Global industrial production PMI data was very mixed, with China remaining
weak, the US looking soft and Europe possibly doing alright. The November
Chicago PMI and Dallas Fed manufacturing indices were pretty soft, with the
Chicago PMI back below 50 after seeing a move higher in October. Meanwhile, the
November ISM manufacturing index sank below 50 into contraction, missing expectations
and falling to its lowest level since June 2009. China's official manufacturing
PMI was in contraction for the fourth month in a row, and the index marked a
three-year low. Further slowdown in Key components of New Export Orders and
Input prices revealed continued softness of external demand and also
disinflationary pressures. Euro zone, Germany and France November manufacturing
PMI indices met or beat expectations and moved up from October levels.

As expected, the International Monetary Fund has added the Chinese yuan to its
Special Drawing Rights (SDR) basket of currencies. The yuan joins the US
dollar, UK pound, Japanese yen and the euro in the basket, marking a major step
toward normalization of China's position as a leading economic power, however
analysts caution that it represents the IMF's opinion about which currencies
are safe for asset managers to hold. Asset managers may end up seeing the IMF's
decision as mainly political. Either way, it is also an important signal that
China is ready to end its strategy of rapid investment-driven catch-up growth
and further work towards raising domestic consumption.

The annual OPEC summit was among the most contentious in years. Saudi Arabia is
now approximately 1.5 years into its campaign to lower oil prices to crush the
US shale industry and consolidate its market share, and pressure was building
on the Saudis to cut output while even inside the Kingdom there was said to be
disagreement about what strategy to pursue. In the lead-up to the meeting, Iran
argued that a majority of OPEC members supported an output cut, but other Gulf
Arab countries stood with the Saudis (at the same time, Iran was insisting it
did not need permission from OPEC to increase crude production). After an
extended closed door meeting on Friday, OPEC delegates emerged to say that they
would leave production levels unchanged (at the "actual" 31.5M bbd
level, above the prior 30M bpd ceiling). The Secretary General said that they
wanted to wait and see how the market develops over the next six months as
Indonesia is welcomed into OPEC and Iran begins to ramp up its oil production
as sanctions are lifted. WTI crude closed out the week around the $40/bbl mark.

Brazil's vast corruption scandal - over 140 businessmen and a host of politicians
have been charged with bribery and money laundering - keeps penetrating higher
levels of the government. On Wednesday, Brazil's lower house initiated
impeachment proceedings against President Rousseff, accusing her Treasury of
repeatedly borrowing money from government banks without legislative authority,
in an attempt to mask deficits - rather than outright bribery or corruption.
Within a month deputies must decide whether to pass the case to the senate,
which requires a two-thirds majority. Senators would then have 180 days to try
the president.

The November US auto sales growth was pretty weak. General Motors and Ford both
widely missed expectations: Ford sales were +0.3% (v 3.2% expected) and GM's
were +1.5% (+2.9% expected). Fiat Chrysler got closer to the mark with +3%
sales (v +3.2% expected). Meanwhile, Volkswagen's sales declined 25% in the
month, in the wake of the emissions cheating scandal.

There were no big M&A deals this week though some may be brewing. Avon
shares rose on report that it is in talks to sell its North American business
to Cerberus as soon as this month. Biotech name Relypsa shares surged on Friday
on an unconfirmed report that Merck may be evaluating a bid.